The most difficult issue we face as brokers of self storage is communicating market value of a property to a potential seller. The formula is complex and requires some subjective interpretation but yields a reasonably consistant answer when applied to the facts of a property. Properties that are overpriced simply don’t sell and properties that are underpriced sell too quickly. Properties that are priced "at the market" sell at fair value in a reasonable time. Since the value question is equally important in financing we thought we would ask Neal Gussis of Beacon Realty Capital to give us some insight into the valuation process and describe how value ultimately translates to a loan amount. You can also see an article on valuation, Cap Rates & Sales Prices, at our website, www.SelfStorage.com, simply click on the Argus Logo then Self Storage Articles. We want to thank Neal for bringing his expertise to our pages.

A question was recently posed to me: "Does the capitalization rate ("CAP rate") differ based on the quality of the property?" A pretty straightforward question; however, from a financier’s standpoint, this question has a short answer but a lengthy commentary on what is the definition of "quality".

The answer is yes, quality does effect the CAP Rate which in-turn has a direct correlation to value. "Quality" counts (in actual dollars).

The CAP rate is a rate of return used to capitalize the net income stream into a value estimate.The formula is

When selling or refinancing a property, an appraisal and/or a loan will commonly be needed.

An appraiser mainly looks at the physical attributes of the property, its location, its market and its operating income to conclude a market value. The two most relied upon methods used by appraisers are the Income Approach and the Sales Comparison Approach.

The Income Approach determines value based on two methods: 1.) The Direct Capitalization which takes the first year’s income and applies a CAP Rate or 2.)Yield Capitalization, commonly know as Discounted Cash-flow (DCF) analysis. Using DCFcash-flows are projected out for a holding period and discounted back to a present value. The DCF method is more accurate for properties that are not yet stabilized. The appraiser also uses the sale comparables among other information to support the CAP rate for the subject property.

The Sales Comparison Approach compares sales of other self-storage properties to the subject whereby an evaluation process rates the sale property as inferior or superior to the subject and then calculates a value for the subject property. The two methods are then reconciled to determine a final market value.

According to C. Ray Wilson, MAI, CRE, President, Charles R Wilson & Associates, Inc.,, properties that are "investment" quality are currently being selling for based upon capitalization rates ranging between 9.5% to 10% . Less than investment grade properties have higher cap rates in the range of 10.5% to 11.5%. An "investment" property will rate "A" grades on all of the following criteria.

Facilities that do not have security, paved drives or rental offices may provide excellent monthly cash-flow, but have limited resale possibilities and limited financing opportunities. Also, facilities that are less than 35,000 square feet are generally not considered investment grade and therefore tend to have CAP rates anywhere from .75% to 3.0% higher..

In a recent Charles R.Wilson & and Associates, Inc. appraisal, the appraiser evaluated a self-storage property in the Sales Comparison Approach section by first taking into account the financing terms, condition of sales and market conditions of the comparable properties. Then the appraisal compared the properties by location, quality, age/condition, and design/size.

Comparisons were judged on the area’s surrounding development, accessibility, and its degree of competition.

The quality refers to the quality of construction/improvements. This entails the material used for construction, the quality of workmanship as well as, amenities such as electronic gates, security including cameras and door alarms. An assessment is made on driveway construction and ease of vehicular maneuverability.

The effective age (the remaining useful life of the property) and overall physical condition. Is the property clean and well-maintained? Is there any deferred maintenance? Physical condition encompasses the condition of the buildings, gutters, roofs, driveways, landscaping, signage etc.

Here the appraiser focuses on design features such as unit accessibility, (single story vs. multi-story) building layout, tenant appeal, etc. . Units on higher levels that are accessed via stairs are harder to rent. A comparison of climate control and non-climate controlled units are made. There is also an adjustment made for the subject’s average unit size in relation to the market data.

The appraiser also needs to have access to complete and accurate books and records.

The lending community is increasingly more selective and more conservative on most types of real estate loans. This is particularly the case on properties that appear to have higher credit risks. Larger experienced operators, larger facilities, newer facilities, proven management, well-documented strong operating track record, well-occupied facilities -- These are all traits which will be able to obtain the most financing opportunities many times at the most attractive terms.

The lender is going to look at the quality of the deal based on the property attributes discussed above, but will also look at the principals and the management of the property.

The strength of the principal(s) is/are going to be strongly analyzed. Lenders look to principals with experience in real estate and, more specifically self storage. Additionally, regardless of whether the loan is recourse or non-recourse, the lender is going to need to have a comfort level that the principal(s) have a solid balance sheet and have demonstrated good borrowing patterns historically.

The loan amount is typically derive from the lower of:

Maximum LTV (Loan to Value) or Minimum DSC (Debt Service Coverage).

See Chart for illustration.

The "quality" of your deal also has a direct effect on the loan amount. Lenders tend to be more conservative with lower "quality" deals. Here is an example of two properties with the same NOI but different "quality":

(25 Yr. Amort)

NOI = $200,000

Cap Rate .10% $2,000,000 $1,500,000 (75% LTV) $131,280 (7.25%)

.11% $1,818,181 $1,272,700 (70% LTV) $119,004 (8.00%)

Overall "quality" is the easiest of all the components of operating self-storage that is controllable by ownership and management. And as you can see it also creates real value.

Neal Gussis is a senior vice president at Beacon Realty Capital, Inc, a financial services firm that arranges debt for self-storage and other commercial real estate owners. Neal has funded more than 250 self-storage transactions totaling nearly $500,000,000 . He can be reached at (312) 207-8240 or at ngussis@beaconrealtycapital.com.